What are the Biggest Risks to Consider as a Potential Franchisee?

Depending on the franchise you choose, your initial investment could range anywhere from several thousand dollars to well over $1 million. This includes the cost of equipment, furniture, technology and professional services, as well as the franchisor’s initial franchise fee. If you buy a franchise, how will you finance the initial investment? How soon can you reasonably expect to recoup your investment?

Along with the initial franchise fee, you will also be required to pay your franchisor a monthly royalty, and you may also be required to make monthly advertising fund contributions. These fees will likely add up to somewhere around seven percent of your gross revenue (not your net profit). Have you considered these fees when preparing your financial projections? Will you have sufficient cash on hand to pay your franchisor (and your employees and creditors) as you grow your business?

Many franchisees are surprised to learn that they can face direct competition not only from other franchisees, but even from their franchisor. When reviewing a franchisor’s Franchise Disclosure Document (FDD) and franchise agreement, it is critical to ensure that you have an accurate understanding of the territorial protections the franchisor offers. Territory rights are not always as they seem, and you do not want to buy a franchise relying on an inaccurate assumption.

Franchisors almost universally reserve broad rights to modify their brand and system standards through updates to their Operations Manuals. If you buy a franchise, will you be required to make costly “upgrades” shortly thereafter? What options will you have if you are happy with your business but your franchisor demands that you make substantial modifications in order to maintain brand consistency?

In addition to reserving broad rights to modify system standards, franchisors also typically reserve broad rights to terminate their franchisees. As a franchisee, you could be at risk for losing your business if you fail to pay royalties or advertising fund fees, you are unable to afford costly upgrades, or even if you fail to meet certain conditions at the time of renewal. In addition, wrongful terminations are a common issue in franchise litigation; and, if you do not take adequate steps to protect yourself, you could find yourself in a fight to save your franchise.

Finally, if your franchisor terminates your franchise, not only will you be out of business, but you may also be prohibited from starting a similar business in your geographic area. Franchisors routinely include non-competition covenants in their franchise agreements, and these covenants are routinely enforced. As with the other concerns listed above, being proactive is the key to minimizing your risk as a franchisee, and this starts with hiring an experienced franchise attorney to negotiate your franchise agreement.